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Introducing the Connect America Fund – USF Reform Overview 

FCC Releases 759 Page Document Late Friday Nov. 18 (Saving Thanksgiving, but not the Weekend)

Since October 27 the telecom industry has been on pins and needles awaiting the release of the document detailing the landmark decision reforming the Universal Service Fund and Intercarrier Compensation system. Rumors have swirled about the release date, and many feared that the FCC would post the document, expected to run anywhere from 500 to 2,000 pages, the day before Thanksgiving. Well, the FCC decided to release the 759 page Report and Order and FNPRM just as many were heading home for the weekend… At least Thanksgiving was spared!

Over the coming weeks, JSI Capital Advisors will analyze and report on many facets of the Order and FNPRM from CAF to mobility to phantom traffic and everything in between; as well as the reactions from different sectors of the industry. An initial look at the document indicates that there will be no shortage of reporting on this topic for the next year, as there will be many follow-up comment cycles, proceedings, public notices and Wireline Competition Bureau decisions.  

So, let’s get down to business! Today we will look at the introduction and overview of the Connect America Fund, including the budget and some broad high-cost support reforms for price cap and rate-of-return companies. ICC will be addressed in future articles.

Introduction and Executive Summary - Why is the FCC Doing This?

The FCC contends that the current USF/ICC programs “are based on decades-old assumptions that fail to reflect today’s networks, the evolving nature of communications services, or the current competitive landscape, [and] are ill equipped to address the universal service challenges raised by broadband, mobility, and the transition to Internet Protocol (IP) networks.” Furthermore, the FCC has a statutory obligation to “update our mechanisms to reflect changes in the telecommunications market.” The FCC has determined that USF and ICC need to be more modern, accountable, fiscally responsible, and market-based—we have been hearing this since the National Broadband Plan in early 2010.

The FCC sets up the USF reform framework with five general goals:

  1. Preserve and advance universal availability of voice service
  2. Ensure universal availability of modern networks capable of providing voice and broadband service to homes, businesses and community anchor institutions
  3. Ensure universal availability of modern networks capable of providing advanced mobile voice and broadband service
  4. Ensure that rates for broadband service and rates for voice services are reasonably comparable in all regions of the nation
  5. Minimize the universal service contribution burden on consumers and businesses

It was interesting that “ensuring reasonably comparable service” was not on the list of primary goals, although the FCC does address reasonable comparability in some interesting ways later in the document. For example, CAF recipients must ensure reasonably comparable data capacity and the FCC suggests that 250 GB per month is an adequate target.

The FCC draws its legal authority for the reforms from Section 254, Section 706, the 2008 Farm Bill, the Broadband Data Improvement Act, and of course, the American Recovery and Reinvestment Act from which the National Broadband Plan was born.

Public interest obligations play a very large role in the USF reforms, as do various benchmarks, ceilings, and floors. One of the most significant requirements is that CAF recipients must provide at least 4/1 Mbps actual speed: “This conclusion was based on the Commission’s examination of overall Internet traffic patterns, which revealed that consumers increasingly are using their broadband connections to view high-quality video, and want to do so while still using basic functions such as email and web browsing.” (Note that temporary waivers can be granted for extreme situations where the CAF recipient cannot provide 4/1 Mbps, but this will be discussed in greater detail in a future article). In addition to the 4/1 Mbps requirement, CAF recipients will be required to offer “sufficiently low latency to enable use of real-time applications, such as VoIP,” preferably less than 100 milliseconds. Finally, capacity must be reasonably comparable, as mentioned above, where “250 GB appears to be reasonably comparable to major urban broadband offerings,” although the FCC is not adopting a specific requirement at this time.

The Budget - $4.5b/year for at Least Six Years

The Order establishes “for the first time a firm and comprehensive budget for the high-cost program,” of $4.5b to “best ensure that we will have in place ‘specific, predictable and sufficient’ funding mechanisms to achieve our universal service objectives.” The budget will remain in place for at least six years and will require a Commission vote to change. The $4.5b breaks down in the following:

Price Cap CAF Overview – Phases I and II

The Order frequently repeats that “More than 83 percent of the approximately 18 million Americans who lack access to fixed broadband live in price cap study areas.” However, the FCC is not outright punishing the price cap carriers for their broadband build-out straggling; instead the FCC is freezing their existing high-cost support and allocating an additional $300m in “incremental support” in the first phase of CAF. The FCC argues that the $300m will “provide an immediate boost to broadband deployment in areas that are unserved by any broadband provider.” The Wireline Competition Bureau will calculate how much of the $300m each price cap carrier is eligible to receive, and the carriers “may elect all, none, or a portion of the incremental support.” Carriers who accept the support will be required to “deploy broadband to a number of locations equal to the amount it accepts divided by $775.” Carriers will have 90 days to decide if they want the incremental support, and how much they will accept. Incremental support has strings attached, too, including aggressive build-out requirements. Carriers cannot use incremental support for existing deployment plans or merger commitments, and “carriers failing to meet a deployment milestone will be required to return the incremental support…and will potentially be subject to other penalties.”

CAF Phase II will tentatively begin January 1, 2013. At least one-third of a carrier’s frozen high-cost support will be required to go towards building broadband networks in unserved areas with no unsubsidized competitor. The intricacies of the price cap CAF methodology are worth a read, but a few points jumped out. First, the FCC is not adopting the ABC Plan Rights of First Refusal proposal as recommended by six price cap ILECs (see The ILEC Advisor: Six ILECs Defend Rights of First Refusal Proposal)—at least not entirely. The incumbent price cap carriers will have the option to accept CAF support for five years “in exchange for a commitment to offer voice across its service territory within a state and broadband service to supported locations within that service territory, subject to robust public interest obligations and accountability standards.” If the ILEC declines the support, a competitive bidding mechanism will be implemented. The FCC decided to adopt a state-level commitment in order to prevent the ILECs from cherry picking “the most attractive areas within its service territory, leaving the least desirable areas for a competitive process.” Additionally, the FCC is not adopting the ABC Plan’s CQBAT forward-looking cost model because the industry did not have adequate time to analyze the model. The Wireline Competition Bureau will soon release a public notice to begin the process of developing an appropriate cost model.

Rate-of-Return Reform – Laying the Foundation

The USF reforms for rate-of-return carriers focus on eliminating “waste and inefficiency and [improving] incentives for rational investment and operation by rate-of-return LECs.” In this spirit, the FCC will eliminate Safety Net Additive support, Local Switching Support (although some LSS support will move to the ICC recovery mechanism), and “support for rate-of-return companies in any study area that is completely overlapped by an unsubsidized competitor.” RoR support will also be capped at $250 per line per month with possible future reductions, and there will be funding consequences for RoR companies with artificially low local rates.

The FCC is taking a “more flexible approach” with RoR carriers than with price cap carriers by refraining from adopting “a mandatory requirement to deploy broadband-capable facilities to all locations.” Instead, RoR carriers must provide 4/1 Mbps broadband to consumers upon reasonable request—for now anyway. The FNPRM will deal with future requirements for rate-of-return CAF recipients as well as capital and operating expense benchmark methodologies. The FCC recommends that the methodology to be developed by the Wireline Competition Bureau “require companies’ costs to be compared to those of similarly situated companies,” which “will provide better incentives for carriers to invest prudently and operate efficiently than the current system.” This methodology will be analyzed in greater detail in future ILEC Advisor articles.

The FCC comes down hard on RLECs who have artificially low local telephone rates, which they call “inappropriate.” Although the national urban average is $15.47 per month, “there are local rates paid by customers of universal service recipients as low as $5 in some areas of the country.” The FCC establishes a 3-phase rate floor starting at $10 in July, 2012 and increasing to $14 in 2013 and then to be set by the Wireline Competition Bureau in 2014 and after. The FCC notes that they could actually set the rate floor above the national average, but “In the present case, we are expecting to set the end point rate floor at the national average rate.” Carrier’s whose local rates are below the benchmark will have their support reduced by the difference between the rate and the benchmark.

Overall, the FCC is confident that “rate-of-return carriers on a whole will have a stronger and more certain foundation from which to operate, and, therefore, continue to serve rural parts of America.” Furthermore, the FCC is “equally confident that these reforms, while ensuring significant overall cost savings and improving incentives for rational investment and operation by rate-of-return companies, will in general not materially impact the ability of these carriers to service their existing debt.”

Coming up Next…

There is definitely much more ground to cover regarding rate-of-return carriers, ICC, Mobility and Tribal funding, the extremely high-cost fund, the waiver process, competitive bidding, access rate arbitrage, and the FNPRM. Stay tuned for analysis of these exciting topics and more!

What are your initial reactions to the Order?

The full text of the Connect America Fund Report and Order and FNPRM is available here.

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